Favorable Changes Made to Charitable Deductions for Contributions of Food Inventory for Restaurants

By Phil Hofmann

Last December, Congress passed and the president signed into law the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The PATH Act makes permanent several temporary tax provisions commonly known as extenders.

One extender particularly relevant to restaurant businesses is the enhanced deduction for food inventory under IRC section 170(e)(3). The enhanced deduction equals the lesser of (a) cost plus half of the property’s appreciation, or (b) twice the property’s cost.

The new law reinstates and makes permanent the enhanced deduction for contributions of food inventory for contributions made after Dec. 31, 2014. This applies to any taxpayer engaged in a trade or business, whether a C-corporation or not.

The permanent deduction is good news, but the new law also made some modifications that are even better news for restaurants. First, for years beginning after Dec. 31, 2015, the new law modifies the enhanced deduction for food inventory contributions by generally increasing the chartable percentage limitation for food inventory contributions to 15 percent and clarifying the carryover rules.

Second, new rules were added regarding fair market value (FMV). In order to use the enhanced deduction, a taxpayer must establish the FMV of the donated food. The FMV has historically been a subject of dispute between the IRS and taxpayers. For contributions made after Dec. 31, 2015, the following new presumptions may be used when valuing donated food inventory:

Taxpayers that don’t account for inventory may elect to treat the basis of donated food as being equal to 25 percent of the FMV of such food.

In the case of any contribution of apparently wholesome food which cannot or will not be sold solely by reason of internal standards of the taxpayer, lack of market or similar circumstances, or by reason of being produced by the taxpayer exclusively for the purposes of transferring the food to an organization described in section 501(c)(3), the fair market value of such contribution shall be determined (1) without regard to such internal standards, such lack of market or similar circumstances, or such exclusive purpose, and (2) by taking into account the price at which the same or substantially the same food items (as to both type and quality) are sold by the taxpayer at the time of the contributions (or if not sold at such time, in the recent past).

While the first presumption might apply to a very small taxpayer using the cash method of accounting, the second presumption will apply to most restaurants. It’s important to note that restaurants can use their most recent selling price to determine the FMV of the donated food. Typically, this should be menu price less any discounts, such as coupons. Historically, some IRS agents have argued that menu price is not a good starting point because the donated food was not sold or is not sellable.

Let’s look at a quick example. Suppose a restaurant’s menu price is $10 for a pizza, and the cost is $3. The computation of the deduction would look like this: $7 is the appreciation ($10 – $3). We calculate the tentative contribution amount by dividing $7 by 2 ($3.50) and adding the cost of $3, leading to a total of $6.50. However, the deduction amount is limited to twice cost, which in this case, is $6.00. Note that anytime the cost to FMV ratio is at least 33.3 percent, the contribution deduction will max out at twice cost.

This new FMV presumption should greatly reduce future disputes with IRS agents. It is also an opportune time for restaurants to think about implementing a food donation program to help their communities while enjoying a tax break.

Phil Hofmann is a tax senior director in BDO’s Restaurant Practice. He can be reached at phofmann@bdo.com.

Accounting Treatment for Promotional Cards

By Vince Stasiulewicz

Amid continuously increasing competition and growth within the restaurant industry, restaurant operators often find themselves actively searching for ways to boost average unit volume and same store sales.

Offering gift cards has proven an effective strategy for attracting new customers and driving sales, as they’ve become an increasingly popular purchase for consumers. According to the NRF’s 2016 Mother’s Day Spending Survey, 43.2 percent of Americans said they planned to give a gift card for the holiday, averaging $2.2 billion. Not only are gift cards convenient for both purchasers and redeemers, they essentially provide restaurants with free advertising via word of mouth and customer referrals.

Given the success of standard gift card programs within the restaurant industry, the use of prepaid cards has crossed over into the realm of promotional marketing. Instead of sending gift certificates, many restaurant operators are experiencing positive results by mailing or giving out promotional cards. A 2010 report from First Data shows customers are more likely to redeem a promotional card than a traditional paper certificate, as they tend to equate promotional cards with free money. Further adding to their appeal for both restaurants and consumers is the fact that promotional cards can be designed to represent a restaurant’s brand image and used to commemorate special events that offer customers a personalized touch.

While the use of prepaid and stored-value cards carries many benefits for restaurants, various types of cards have distinct and unique accounting treatment ramifications under U.S. generally accepted accounting principles (GAAP). It is important to understand the accounting treatment for promotional cards when considering whether or not to offer them.

In general, promotional cards should be accounted for in the same manner as coupons. Any costs associated with printing and mailing the promotional cards should be expensed as incurred, and the discount should be recognized as a reduction of food and beverage sales upon redemption. Unlike prepaid and other stored value cards, promotional cards are not recognized as liabilities upon issuance, as no cash/ tender was received from the customer and therefore no liability is incurred.

However, unlike coupons, it is recommended that promotional cards be tracked upon issuance in order to reconcile with thirdparty servicer reports or internal point of sale (POS) systems. One potential tracking system might be to record the card values at their gross amounts, offset by a contra liability account to adjust the value to zero since no actual liability exists. When a promotional card is redeemed, the liability account is relieved to reflect the use of the card, and the contra account must also be relieved in order to reflect revenue as zero.

In addition, breakage is not an applicable concept as no cash/tender was received upon issuance of the promotional card. Using third-party servicer reports or internal POS systems, promotional card expiration dates and usage should be monitored, and the gross and contra liability accounts should be reversed upon expiration or determination that the promotional card will not be redeemed.

The intended benefits of increased foot traffic and same store sales growth driven through promotional cards are indeed attractive. However, the implementation of such incentive programs does not come without its challenges. It’s important for restaurants to establish an appropriate tracking mechanism to monitor these cards, and it’s equally important to ensure these promotional cards are appropriately accounted for in accordance with GAAP. The failure to do so could potentially offset the intended benefits of promotional card use.

Vince Stasiulewicz is an audit senior manager in BDO’s Restaurant Practice. He can be reached at vstasiulewicz@bdo.com.

Are You Getting the Most out of Your Data? Why You May Want to Consider a Loyalty Program

By Kirstie Tiernan

One of my first restaurant clients was a place I visited often, sometimes multiple times a week— my go-to for business lunches.

When I approached the restaurant with an opportunity to help it better serve its customers leveraging the power of its own data, the first step was to review what it already had. Since it didn’t have a loyalty program in place, we started with a simple review of its OpenTable reservation data to identify the number of visits the restaurant received per customer.

As we walked through the report, we noticed mostly one or two visits per person— unsurprising, given the restaurant was in a tourist area of downtown Chicago. However, as we made our way down the list, we saw one patron who had visited 36 times within the last six months. That loyal patron was me! It made for a bit of an awkward moment, but the general manager quickly realized how easy it would have been to reward my loyalty had he just known who I was. Implementing a loyalty program is one way restaurants can harness the power of data analytics and better understand who their customers are, as well as what will keep those customers coming back and spending more.

Choosing A Loyalty Program
A loyalty program rewards customers for repeat business by offering discounted items or VIP experiences. There are several types of loyalty programs used by businesses to reward customers. The methods that work best for restaurants are either points-based or tiered, which reward customers for dollars spent and frequency of visits.

Points-based systems are more short-term focused and provide more immediate rewards for customer business. Whether it be a free appetizer or a discount on a meal, the points system encourages customers to come back to use their reward. The tiered system gives customers a unique benefit for being longtime customers. It enhances the customer experience by providing special access or exclusive opportunities.

You can leverage data you’ve already collected to determine the type of loyalty system to use. For example, how much more do patrons spend when they use a discount or coupon on an appetizer? Restaurants with customers that spend more using discounts may want to consider a points-based loyalty program. If you have customers who frequently attend special events and spend more to do so, the tiered system may be a better fit.

Use the Data
It’s easy enough to develop the right questions to determine which analytics to run. The hard part is getting the data analytics-ready. To be analytics-ready, the data needs to be clean—populated, accurate and complete—in order to be used effectively.

When implementing a loyalty system, it’s important to ensure that you have the resources in place to make use of the data you gather. The analytics should be concise, informative, accurate and user-friendly. A variety of off-the-shelf analytics tools are available to run general analytics on labor, inventory, food cost, menus, customer behavior and social media.

If you already have database software inhouse, you can create your own analytics by pulling your Point of Sale data, accounting information, social media references, online reviews, loyalty program details and reservation data all into one database and running your reports there. Visualization tools, like Tableau, are a low-cost way to help make results easy to interpret and actionable. Once you have the data in one place, you can begin to analyze it and adjust your business practices accordingly, moving from volumes of unused data to intelligent business decision making. For example, you can analyze your customers’ spending on alcoholic beverages and assess their potential appetite for a wine-pairing dinner.

Best Practices
Now that you have a preliminary grasp of the data and are getting ready to deploy a new loyalty program, you should consider the following:

Provide an immediate incentive and make it easy to join. Discount the meal when the customer signs up and take only the information you absolutely need, like name, birth date and contact information.

Personalize offerings to members. One of the top reasons loyalty programs fail is because the contact with the guest is too general. Use the data to learn more about your customer and create specialized incentives and offerings aligned with what he/she wants.

Reward customers for any sale associated with the business (e.g., catering, restaurant dining, merchandise purchase, etc.).

No one puts those plastic tags on their key rings anymore. Use a phone number and/ or email address as the ID for the card.

It costs more to acquire a new customer than to retain an existing one. Loyalty programs might not be right for every business but, for some, implementing a system can help the business to better know its customers, offer them meaningful and relevant promotions, and connect with them on a regular basis, ensuring that they will come back for more.

Kirstie Tiernan is a director at BDO Consulting. She can be reached at ktiernan@bdo.com.

How is Technology Changing the Way Restaurants do Business?

By Kari Maue

New technology seems to emerge daily, so it’s no surprise that it is changing the way restaurants do business. During our recent Restaurant CFO Roundtable held in Cincinnati, Bill Lindsey of Compeat Restaurant Management Systems spoke about restaurant industry trends and how new technology is paving a new road for restaurateurs.

Tech Spending Trends Upward
On average, restaurants are spending 2.5 percent of their revenue on technology, according to Hospitality Technology Magazine’s 2016 Restaurant Technology Study. Of the participants, 44 percent expect to increase their spending on technology by 1 to 5 percent from the prior year. When considering how to allocate dollars on technology, it’s important for restaurants to assess the costs and benefits of the various available software and hardware. For instance, restaurants need to decide whether it makes sense to purchase a particular software through licensing or switch to a subscription service (software as a service). Also, should they purchase and manage a server or use cloud-based systems?

Payment Technologies
From Apple Pay to phone apps, it has never been easier for consumers to spend money. Mobile wallets like Samsung Pay, Apple Pay and Android Pay store credit or debit card information securely along with loyalty cards, coupons and other rewards programs. These wallets use near-field communications (NFC) to interact with mobile wallet payment terminals to allow you to pay securely using your mobile device.

It’s important for restaurants to leverage these new technologies to meet customers’ hunger for convenience and security. Some restaurant chains have developed apps that can be connected to mobile wallets, allowing customers to order their coffee or meal through the app and pay for it, or to split checks between groups at a table. Not only can new payment terminals and systems reduce credit card fraud, apps that use mobile wallet also allow restaurateurs to transform their loyalty programs and customer experiences, as they can link to rewards programs and track customers’ locations to ensure their items are ready upon their arrival.

Beacons and Geo-fencing
Beacons are small, cost-effective devices that use Bluetooth connections to communicate with mobile phones, and some restaurants are using these technologies to enhance their marketing strategies and improve customer experience. These devices can be used to engage and influence customers while they’re in restaurants or nearby. For instance, they can determine whether a guest is a repeat customer, allowing restaurants to tailor the payment process and dining experience accordingly based on individual preferences. Beacons can also identify customers who are nearby via a restaurant’s app and engage by sending coupons or special menu options.

Geo-fencing uses GPS from a mobile device to create a virtual barrier. Once a device has crossed the barrier, location-specific ads can be distributed to mobile devices to encourage potential customers to stop into the nearby location. This technology can also be used to notify a restaurant of the potential arrival time of the customer. In the case of a carryout order, the restaurant can be notified once the customer is within a certain distance, letting them know to begin the preparation process. This way, the food is fresh upon the customer’s arrival.

Finding Restaurants and Reservations
From review hunting on Yelp to making reservations on OpenTable, approximately 60 percent of consumers use mobile devices to assist with restaurant selection and reservations.

Some websites like Table8 allow you to purchase a hard-to-get reservation to an in-demand restaurant, while others like Table Savvy can fill tables by offering the customer a discount. Knowing that customers often rely on technology to make dining decisions, it’s important for restaurants to embrace these opportunities to get in front of techsavvy customers and effectively compete.

Back of the House Technologies
Some restaurants are using technology to create efficiencies by integrating their inventory, labor scheduling and employee management software to help reduce prime costs. Ordering software, for example, can integrate with vendors’ software for purchase orders, as well as provide suggested orders, that allows employees to count what they have against what they need. Scheduling tools can assist with determining adequate staffing for a given guest count, as well as revenue forecasting.

New and emerging technology enables restaurants to meet customer demand for more customized experiences, while providing intel that restaurants can further leverage to understand their visitors. In a recent blog post, my colleague Kirstie Tiernan explores how restaurants can get the most out of customer data.

While it’s difficult to predict upcoming trends in restaurant technology, we encourage restaurants to become familiar with today’s technologies and understand their impact on the industry.

Kari Maue is an audit senior manager in BDO’s Restaurant Practice. She can be reached at kmaue@bdo.com.

Do you deliver? State and Local Tax Considerations for Restaurants

By Dana Zukofsky and Mike Feiszli

With the takeout and delivery market estimated at $70 billion, according to TechCrunch, it’s no wonder restaurants of all types— from QSR to full service—are joining the delivery bandwagon. But for those companies debating whether to get into the game, there are some important state and local tax implications you must first consider:

Crossing City, County or State Lines May Trigger Nexus
If your restaurant delivers to customers in an adjacent city or ships to customers in another county or state, you may trigger sales tax nexus. This creates reporting and filing responsibilities for multiple jurisdictions.

Taxability of Food and Beverages Varies by State
If your restaurant delivers or ships across state lines, you should be aware that the definition of “food” varies by state, impacting taxation. In the “Streamlined States” such as Michigan, New Jersey, Kentucky, Nevada and Ohio, the definition of food does not include alcoholic beverages, dietary supplements, soft drinks or tobacco. Also, beverages delivered with food may have different taxability. For example, if you’re a pizzeria in a state like Ohio where most food items are not subject to sales tax unless they are consumed on the premises where they are purchased, and you deliver an order of pizza and beverages to a local customer, the pizza is tax-exempt but the beer is taxable. In addition, hot and cold food may have different taxability.

Taxability of Delivery Services Varies by State
Different states may also define and tax services differently. Some states, such as Connecticut and New Mexico, tax nearly all services, including delivery. Other states, such as California, tax virtually no services, and yet other states tax only designated services. This variation makes it tricky to determine whether you are required to charge tax on delivery fees. In addition, what is considered “catering” or “delivery” in one jurisdiction may fall under another category elsewhere. For example, in New York, delivery charges follow the taxability of the food and drink being delivered. In Florida, depending on if the restaurant has a pick-up option, the delivery charges may or may not be taxable. If delivery charges cannot be avoided, they become part of the sales price of the meal and subject to sales tax. Optional delivery charges that are separately stated and not part of the taxable meal are not subject to sales tax.

This is further complicated by the use of third-party delivery providers. In some states, such as Missouri, transactions between a restaurant and a third-party delivery service are taxable; however, the transaction between the delivery service and the end customer is tax-exempt.

Sales Tax Rates May Vary Between Location of your Restaurant and Customer
Once you determine if your delivery items are taxable, you need to determine the correct sales tax rate. The rate may vary between your location and your customer’s delivery address. Therefore, be sure you understand your state and local jurisdictions’ sourcing requirements (origin vs. destination). Rates for food and beverages can also vary between locations. Take for example a transaction that occurs between an Indiana customer and an Ohio restaurant. In Ohio, the sale of food off the premises is exempt from Ohio sales tax, so the Ohio restaurant would not charge Ohio sales tax to the Indiana customer. However, because this is an interstate transaction and both states are destination sourcing states, we look to the taxability of the delivery items in the final destination. In Indiana, sales tax applies to restaurants’ sales of food regardless of whether sold to dine in or take out. If the Ohio restaurant is delivering the food via their own vehicles, they have established nexus in Indiana and should charge Indiana state sales tax and local food/beverage tax (if applicable in that jurisdiction) on the delivered food/beverages. The charges for delivery of prepared food in Indiana are subject to sales tax.

Launching delivery service for your restaurant can open doors to new customers and help you grow your business. However, it is a complex undertaking that could increase your exposure to unanticipated tax liabilities— meaning it’s in your best interest to plan carefully, understand your responsibilities, and identify the impact to your bottom line before forging ahead.

Mike Feiszli is a senior director in BDO’s State and Local Tax Practice. He can be reached at mfeiszli@bdo.com.

Dana Zukofsky is a director in BDO’s Restaurant Practice. She can be reached at dzukofsky@bdo.com.

The speakers kicked off the webinar by discussing the aging franchise business model. “When we look at the billion-dollar range, the average founding date for quick service restaurants (QSR) is 1967 and the average founding date for fast casual restaurants is 1975,” said Butkus.

The prevalence of older systems and slowing development of new units since the 2008 recession sets the stage for healthy store closings and remodeling activity over the coming years. Some restaurants partake in more frequent, less expensive “refreshers,” but most chains follow a regular seven-year cycle with a more formal program in place, consisting of less frequent, more extensive remodels, despite the higher price tag.

A number of factors are contributing to an uptick in remodel activity, including a trend among QSRs to incorporate more fast casualinspired elements in stores, such as more comfortable eat-in dining areas, upgraded technology and bathroom updates.

If a restaurant completely changes locations and must build from the ground up, it can face an entirely new set of costs, in addition to existing ones. Thus, restaurants should be careful when considering investing in a site that may not be feasible as a long-term location.

Speakers stressed that it is not enough to rebuild for the sake of having a “shiny and new” location. It’s important that restaurants have a plan in place and an overall return on investment strategy that leverages the remodel. They also noted that franchisees might consider reserving funds annually for remodeling to ensure all necessary renovations can be completed in a timely manner. To illustrate this point, Butkus points to Panera’s recommendation that franchisees set aside $25,000 per year for maintenance and $200,000 in years 6, 11 and 16 for remodel programs.

With regard to return on investment and the costs and benefits of remodeling, Phil Hofmann weighed in on the tax implications. According to Hofmann, the IRS is helping franchisors and franchisees pay for these remodels under Rev. Proc. 2015-56, which was introduced approximately six months ago.

Under the new procedure, qualifying remodel costs will receive an immediate deduction of 75 percent. The new procedure stipulates certain projects, buildings and costs that qualify for the deduction. For example, the remodel must be on a retail or restaurant facility; a headquarters renovation does not qualify. Activities such as painting, replacing floors and ceilings, and moving walls can qualify, but property depreciated over five years is an excluded cost.

Rev. Proc. 2015-56 is effective immediately for tax years beginning in 2014. This new procedure is financially favorable for restaurants, and many have elected to take advantage of it on their 2015 tax returns by making a change in accounting method, though the procedure can also be elected later.

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